Transcript Investment Policy

What the World Has Learned
& What It Is Still Learning:
A Global Forecast
Jay Taparia, CFA
Managing Director, Sanskar Group of Companies
Lecturer of Finance, University of Illinois @ Chicago
Media Consultant, CFA Institute
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About Jay Taparia, CFA
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On behalf of CFA Institute, a public speaker / educator of
business journalists on investments, financial statement
analysis, and accounting tomfoolery since 2001.
Managing Director, Sanskar Group of Companies (Sanskar
Investments, Sanskar Tax & Accounting, and Sanskar Insurance
Services), Chicago, IL.
Former Senior Portfolio Manager, Bank One Investment
Advisors (now called Chase).
Author of Understanding Financial Statements for Journalists
(www.marionstreetpress.com or www.amazon.com).
Finance Lecturer, University of Illinois at Chicago, since 1999,
in financial management, corporate finance, investments /
personal finance, and international finance, and more recently
new venture investing.
Contact Information: [email protected]
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What is a Forecast?
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A forecast is simply an educated guess, but it is still a guess
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We as analysts will always be wrong – so we might as well treat
this as an art.
Being a number-cruncher may be a disadvantage. Having
experience in “randomness” may be an advantage. Abstract
thinkers like artists may actually be better employees than
economists?
So there is no point to be part of a “consensus” if all of us are
giving essentially the same number
Why is it that economists have failed to predict the last 7 of
the 9 recessions (aka the key turning points)?
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Fear of being different from the rest of the “consensus” and thus
losing their job?
Econometric models may be “overused?” What do we need to do
differently?
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Why conform? Aesop’s Fables re: the Ant Colony
Where Should We Really Start?
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Start from the Top, then Drill Down
 The economy is made up of industries.
 Industries are made up of companies.
 Companies are made up of people.
So instead of watching statistics, why not watch people? We
are generally more chaotic and definitely more interesting
than “bird watching.”
We all love to watch “people,” right? The randomness and
craziness of ourselves (i.e., validates Reality TV).
The Story of Husbands and Wives – Jay’s experience in
Meeting with Private Clients and discovering who made the
most investing mistakes.
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Process Should Be What Now?
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Instead of relying on one statistic, why not put several
together to get a better conclusion?
 Average age of Xbox User vs. Average Age of Marriage
=> Expected Age of Divorce?
Why believe too much in the numbers and have no life?
When you can have a drink, mingle, get to make friends,
and hear the real truth at a cocktail party (not just
rumors, but new factoids from other people’s
inebriations)
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Blunt Statement on Analyst Forecasts
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Hypocrisy between what we are taught (PV of cash
flow) vs. what we see in reality (EPS and PE Ratios) to
determine the value of the stock.
Analysts need to get rid of the expensive Italian suits,
eating real food, and start sticking their hands in the
dirt to get to the real truth (what was ever wrong
anyway with playing in the sandbox?)
 Conformity is our true disadvantage to our
innovation and service to the customer.
 I think we could look at the author Herman Hesse
(his book called Siddhartha) on reflecting on his
rebellion as a good example of what we really need to
do more – question what we already know.
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Our Agenda
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The Big Picture – What Have We Learned
What We Still Have to Learn – Key Global Issues
 Impact of Demographics
 Natural Resource Supply and Demand
 Technology and Science
 The New Expensive Wars We Fight – Terrorism,
Corporate Fraud and Financial Reporting Abuses
Changes in the Financial Services Industry - Beyond
the Impacts of Key Global Issues
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The Big Picture – What We Have Learned
The Longest History of World Peace since WWII
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We have experienced increases in personal wealth, rather
than destruction (even literally)
Technological advances have modernized our lives, but also
commoditizing itself and other industries (deflationary)
Large leaps in medicine/biotech and human longevity
The world has gotten closer – with cultural, language, and
economic barriers lower – increased mobility, immigration,
and trade
Higher efficiency of world financial markets due to
electronic research, electronic funds transfer and electronic
exchanges (i.e., technology)
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Bottom Line –
We prefer life (and advances in life) and
are possessive of it – profit and
happiness being key motivators!
This is driving our future actions
politically, economically, and socially
This makes forecasting very easy.
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Impact of Demographics
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World population expected to increase to 7.2 billion by
2015 up from 6.1 billion currently  Rate of population growth will have diminished
from 1.7% annually in 1985 to 1.3 % today, to 1% in
2015.
 More than 95% of increase in world population will
be found in developing countries, nearly all in rapidly
expanding urban areas (India, China…still)
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The world’s population is becoming bipolar (no pun
intended) – with emerging market populations on the
rise while developed nations on the decline
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Impacts on Various Markets
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Emerging Markets  In particular, Asia and Latin America
 GDP will be strained or offset by such population growth
 Countries will have to “innovate” or use “innovation”
(technology leaps) to maximize existing resources
 50% of India’s population is < the age of 18 and has the
highest rate of growth in IT professional graduates
Developed Markets –
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Increased life expectancy, and falling fertility rates will
contribute to a shift toward an aging population
GDP will be strained or offset by higher pension costs
Health and social systems will be pushed to the max (40%
of costs attributable to 3% of patients in the US)
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Identify Opportunities –
Learning from Our Problems
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Emerging Markets –
 Have advantage to apply new technologies to maximize
resources in urban areas
 Have advantage to direct knowledge and technological
resources to young population base in the areas of
technology (India, China, Philippines)
 Privatizations (if done properly) is the only way to
unlock value and re-direct resources to fund growth – not
always a well-received solution
Must upgrade Income and Capital Spending – Takes time
and is LT. This becomes an investment criteria for looking at
new opportunities. (Singapore, Inc.)
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Identifying Opportunities –
Learning from Our Problems
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Developed Markets –
 Strong GDP growth can be created by “youthful”
demographics that have earnings potential.
 80% of the U.S. wealth is concentrated with 40% of the
population age 50+(100 million Baby Boomers)
 Worse age imbalances found in Europe and Japan
 Longer life expectancies are straining Health, Welfare,
and Retirement Systems (Florida often referred to as
“God’s Waiting Room”) = Hospitals are considered
seasonal.
Solution is via Immigration – the U.S., Canada, and Great
Britain have grown LT technologically, and thus,
economically via “importing” new perspectives and
personalities – this has been key growth driver for the U.S. –
3.7% per year for past decade = sustainable growth
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Natural Resource Demand
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Sustained economic growth + population increases will
drive nearly 50% increase in demand for energy over the next
15 years.
Total oil demand will increase from 75 MM barrels per day
to more than 100 MM barrels per day by 2015 (equal to
current production levels)
Natural gas will be key energy source of choice (growth of
100% by 2015) mainly stemming from tripling of gas
consumption in Asia.
Asia will be key consumer of oil from the Middle East,
while the West lessens its dependency (and hence, cyclicality
in its economy)
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Natural Resource Supply
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80% of world’s available oil still in ground
95% of world’s natural gas also still in the ground
Renewable energy resources still expensive and still R&D  Governments haven’t figured out how to subsidize
development
 Prone to cutbacks since R&D is a luxury expense outside
of pension and interest costs
No change in use of nuclear energy usage – stays at current
levels
We are still biased toward fossil fuels given easy access and
lower cost
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Identifying Opportunities –
Learning from Our Problems
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Suppliers will still have LT pricing power given availability
and low cost
Urban areas will be key users of energy usage, especially
from Asia
However, the new urban areas will be environmentally
challenged
 Pollution control not addressed for Emerging Markets – not
interested in hindering growth via higher costs
 Technology (fuel-cells and hybrid engines) will only reduce
this concern as their costs decline.
 Environmental (global warming) and health care costs are
going to be backend-loaded.
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Technology and Science
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Technology is also making profitability in the tech
sector almost non-existent –
 Technologists are not financially-adept = they love
just building things (Lucent / Bell Labs & phone
innovation example)
 Many thought that technology had its own secular
trend and was not tied to the economic cycle – how so
untrue!
 Technology is a capital input as much as the
typewriter or new manufacturing equipment.
 Excess competition exists and hence, expect
consolidation and a few large players to survive in
the end
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Opportunities in Technology Sectors
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Wireless – saturated, but new technology life cycle
 Telephony saturated – little growth
 Data application is the new life cycle, however,
adoption rates slower given that applications are not
necessarily useful to average user
 Small screens on phone and PDAs limit usability by
mainstream
 But wireless data applications are the key to the
future when integrated with existing network
systems.
 In the U.S., where we suffer from “workaholism,”
convergence is key with one machine having cell
phone, PDA, broadband wireless email, and
eventually some form of telepathy technology linked
to the boss
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Who Has Advantage? – The User
Learning from Our Problems
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Technology User Gains > Technology Manufacturer Gains
The Technology Industry has shot itself in the foot with
deflationary pricing power  Extreme Competition ~ U.S. / European Football / Cricket
 Moore’s Law – data density on a chip is still doubling every
18 months and will continue to do so until 2017 according to
Moore himself
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Who Has Disadvantage? – The User
Learning from Our Problems
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Workaholism – “all work and no play”
 Instead of freeing us, technology has “bound” us to work Multitasking reduces our productivity and brain resources
for processing (2 tasks ↓ 29%, 3 tasks ↓ 53%)
 Avg Vacation Days including Holidays = US = 13, Italy =
42, France = 36, Germany = 35, Britain = 28, Japan = 25
(has declined)
 Surveys point out that getting 2 weeks of extra vacation
more desirable than 2 weeks of extra pay
 We in the US still have to learn that downtime means
more productivity – despite our insatiable need to
promote shareholder value – for now anti-depressants
should continue to do well in future
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Science Trends – The Demand
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Demographics driving health costs, but industry not equipped
 Large 50+ generation in developed nations driving future
health care costs (historically viewed as “necessary evil“ by
CEOs)
 Bang for the buck higher in technology than in health care,
especially during recessions – hence CEO reluctance
 16% of US GDP spent on medical care – within a decade this
will be 25%!
 Search for the “fountain of youth” by big Society = for now
in the form of just looking younger and better looking
 If you believe a little bit of Darwin’s Theory, this is deeply
rooted in other mammals (female birds)
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Science Trends – The Supply
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Health Care Productivity Poor in general –
 Grew at 0.7% from 1995-2000 vs. 2.6% annual rate for the
rest of the U.S. economy
 Imagine what this is like for socialistic, government-run
systems!
 An efficient industry and generally not receptive to
software technology to improve quality of service
 This is the only industry that added jobs in the last decade
here in the U.S.
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Science Trends – The Supply
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In drug development, all “easy fruit” and “cosmetic drugs”
have been picked –
 We have become a very “Botox and Silicon” World
 50% of all patents expiring in next 5 years among big
pharmas
 Cancers, heart disease, gene therapies considered
expensive R&D
 Hence, consolidation and higher legal bills inevitable to
maintain growth and prevent drugs from going generic so
quickly
 Big Pharma – all testing a new business model = merged
entities
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Science Trends – The Equilibrium
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Health care costs are increasingly viewed as an “investment”  Studies show society spends $1 on health care in the 1980s,
and receives up to $2 of benefits
 Treating low birthweight babies have added 12 years to life
expectancy, producing net benefit to economy of $200,000
per child in the U.S.
 U.S. spends $1 billion a year treating migraines – the
opportunity cost is $13 billion annually in lost work days
and reduced productivity
 Age related illnesses (heart disease, strokes, arthritis, and
back problems) already account for 20% of health care
spending => This will only rise in the future for most
developed nations
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Opportunity in Science Trends
Learning from Our Problems
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Health cost reduction found in Prevention and Detection  Reducing high levels of obesity, smoking, alcoholism
 Early diagnosis of diabetes and high blood pressure
 R&D in the area of minimal invasive therapies – drastic
reduction in heart treatments
 General awareness to public that “health is truly wealth” –
even in the areas of alternative medicine
Cost reductions also found via bias toward generic drugs  Generic manufacturers stand to gain in the Long Term and
not necessarily ST
 They are branching into being “specialty” drugmakers to
hedge legal battles with big pharmas – eventually they will
have to work together – they need each other
 Arbitrage opportunity still exists in buying drugs from
overseas – not just Canada, but India, E. Asia as well.
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The New Expensive Wars We Face Global Terrorism
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A total disregard for human life –
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When it was normal to “win” if bad guys could lose
out of fear of capture – now they have no fear
What the Greeks have coined a Pyrrhic Victory
where both sides lose even if one side wins
Industries Impacted –
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Expands the security industry (+) for the whole
world given increased integration and global
interaction
Insurance industry also impacted (-) with infinite
(and still uncertain) amounts of premium to pay for
extreme uncertainty.
 The Sears Tower in Chicago noticed its insurance
costs skyrocket by 50% post 9/11.
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Tragedy and Pain…
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Unfortunately, are ways we humans actually learn
how to share and improve the way we do things –
 9 /11 and various ethnicities in World Trade
Center
 Iraq and the Middle East
I have personally built another 9/11 into my
forecast – it is a new war we have to consider and
you really cannot forecast this with an econometric
model
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The New Expensive Wars We Face –
Financial Reporting Abuses & Governance
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Recent survey by an executive research firm has
extracted how that on average 40% of a CFOs time
is spent looking for a new job
On average, auditors who bring up accounting
issues and changes with management are refuted
40% of the time (in other words, they give in)
Who Wins with Higher Reporting Requirements
and Sarbanes-Oxley?
 Accountants themselves = higher salaries
 Investors still have to learn financial statements –
only then they will win.
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So Where Do We Go From Here?
As a the Finance Professional & Industry?
As the Investor and the Stock / Bond Markets?
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Impacts to the Developed Markets & Investors
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Bonds are going to be a key asset class given demographic
shifts in retirees and pension protection needs – the game
with spreads will only get more complicated in understanding the risk premia that go into it
Credit analysis is going to require in-depth knowledge of
off-balance sheet debt and pension accounting (currently
bond traders only quote debt ratios based on ON-balance
sheet debt, not OFF)
Information flow is burgeoning and with higher speed of
dissemination – expected higher volatility across all markets
and asset classes
Large market booms hardly likely in the future, but will
exist in the form of style fads (like the evolving flair / bellbottom pants)
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Impact to the Finance Professional
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Knowledge is power – higher need for continuing education
 We must practice “voracious reading” – but not just on
company financials and industry trends
As an individual advisor – I can truly say the demand for
knowledge in both financial planning / structuring and
product is high.
Additional Education Needs of the Financial Professional or
CFA Charterholder
 Financial Planning
 Tax Rules and Tax Law, including Estate Planning
 Life, Health, LTC, Disability Insurance and how it impacts
Assets under Management
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Impact to the Financial Services Profession
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According to a survey in 2002, 1/5th of millionaire
investors around the world are working without a
financial advisor and increase of 30% over 2001.
 Mostly of sample working with full-service
brokerage firms and increasingly dissatisfied
 Brokers got a D grade, Financial Planners got a B
grade
 23% of millionaire households now use planners
instead of brokers up from 14% in 2000.
 There are 3x the number of advisors chasing after
the $3 million + net worth population
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Impact to the Financial Services Profession
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Bottom Line? – The marketing phrase “wealth
management is a joke” without continuing
education.
 We are still plain Jane asset managers and are not
equipped to give a larger realm of advice to our
clients.
Clients will still be left “confused” on conflicting
information from many different providers and
thus will not feel “trust.”
 Something well known to us if they make movies
like “The Boiler Room” and “Wall Street” on our
industry
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Thank You!
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